Understanding Risk

[emacknight]

In a generic restaurant there are four players: owner, cook, waitress, dishwasher.

1. The owner risked her capital to start a business--she is a capitalist and entrepreneur. She had to lease space, renovate, get licenses, and buy equipment, all before being able to generate revenue. And after all that she has to buy inventory (food) that will allow her to generate revenue. A typical restaurant can easily have $1000 worth of food in inventory before opening the doors (not including alcohol). With the idea being that it will turn into $4000 worth of revenue. The owner had to put up that $1000 in order to generate $4000, some of which has to pay rent and bank loans.

And all of this has to happen before she draws salary. It's not uncommon for a restaurant to take a year before it posts a profit. (it typically takes three years for a vineyard to turn a profit). Chances are that during that year, the owner is living off her savings (capital) in the hopes the restaurant will be successful (generate profit). If customers don't show up, the restaurant fails, she loses it all, and will be forced to give the food away to a charity and sell the equipment at auction.

That is risk. Without the evil capitalist there are no jobs, unless of course we all want to eat at the government cafeteria.

2. The chef/cook is a skilled tradesmen. She risks her time, in that her ability to develop her skills impacts her future earnings. A year spent in a failed restaurant may make her worth less than a competing chef at a successful restaurant. But note that she'll still be paid her hourly wage for showing up and cooking. This is opportunity cost, the lost potential. She needs to keep improving year after year in order to increase her earning potential.

I see this position as having shared risk. The restaurant will invest in a chef hoping she will bring in customers. The chef invests in both herself and the restaurant, hoping to improve her career. This is where you will see profit sharing and bonuses tied to performance. But you will also see the understanding that in skilled trades the "profit" is based on earning potential, not directly as income.

That is why with skilled trades it is expected that salary will increase with time, since their skill increases with time. After a year, the cook is worth more, and will demand more, but only if she improved her skills sufficiently. If customers don't show up, the cook will still be paid, but her earning potential will likely be lower as a result. It is also possible that the restaurant doesn't *need* more skill. If the cook wants more money she'll have to move to a different restaurant.

Hence, the cook invests in herself. But this position is being increasingly eliminated in favour of pre-fab food out of a vacuum sealed package. Skilled cooks are expensive, machines to prepare massive amounts of gooey alfredo are not.

3. The waitress works on tips (aka she is a salesman working on commission). She also bares some level or risk. However, her income isn't so much dependent on the success of the restaurant, but instead on a combination of its popularity and her ability to sell. When she chose to work at that restaurant, she risked the marginal increase had she worked somewhere else. But unlike the chef, this does not impact her future earnings.

She thus has an agreement with the restaurant to share some of the risk. Showing up to work doesn't get her paid. She needs to show up, have customers, and push the alcohol sales.

If customers don't show up, the waitress won't be paid, but her earning potential likely won't change.

This position is also frequently eliminated in favour of walk up counters, and highschool students.

4. Dishwasher*: He represents unskilled labour and thus risks nothing. If he shows up (sober), and washes the dishes, he'll get paid. He is a valuable member of the team, and is paid accordingly. But his wage will be industry standard, and thus there isn't an opportunity cost associated with where he works. He doesn't get to improve his skills and thus his income. His salary is thus dependent on availability of other dishwashers. There are times when it's hard to find dishwashers, so his salary will go up. Other times there are lots and his salary will go down. This is known as the law of supply and demand.

If customers don't show up, he still gets paid. If the restaurant closes he gets the same job some where else. His salary and earning potential are entirely dependent on the health of the restaurant industry. Lots of restaurants means more jobs means more money. If a bunch close at the same time there will be too many available dishwashers and his salary will go down.

What's important for this discussion is that the dishwasher doesn't carry any of the risk, and thus doesn't get any of the reward. If the restaurant closes the owner loses her capital, and with that the ability to open another restaurant. The dishwasher loses his job, but not his ability to go to another restaurant.

What's even more important is that the dishwasher always has the opportunity to save and start his own restaurant is he wants to share in the profits. But with that comes actual risk.

*Dishwashers are awesome, and nothing here should be construed as disparaging remarks towards dishwashers.

[XT]

Sure, I agree with your overall assessment of decreasing or increasing risk. Obviously the owner takes the greatest risks but has the greatest potential for reward. The others take decreasingly smaller risks and decreasingly smaller potential for the reward (a lot of times the main chef in a restaurant has an actual stake in the enterprise though, but it would still be less risk than the owners).

It shouldn't really be a debate, but I'm guessing that it will turn into one.

-XT

[John Mace]

is this a spin-off from the What Should Replace Capitalism thread, where some were arguing that workers get a share of the profit?

[Nadir]

I'd title the thread "Understanding Small Business Risk."

[bump]

Someone's sure to show up and go on about how the evil white company hates the dishwasher because he's brown skinned and poor, and how the company should pay him a wage of 10 dollars an hour because he should be loved, or some other softheaded BS like that.

[XT]

Originally Posted by Nadir

I'd title the thread "Understanding Small Business Risk."

Why? Do people who invest in and create large businesses have no risk? Do large companies never fail? Do investments in large businesses never fail? Are they all sure fired, guaranteed risk free deals?

There is risk in everything, and as your rewards go up so do your risks. Rich people can become poor people if they fuck up badly enough, and don't understand risk.

-XT

[Whack-a-Mole]

Originally Posted by xtisme

There is risk in everything, and as your rewards go up so do your risks.

Unless you are a CEO of a bank or investment firm in which case you can apparently bring your company to the brink of ruin, smash the global economy and collect record bonuses for doing it.

And even if they did lose their job they have golden parachutes that keep them from sharing anything like what we would call risk.

[The Hamster King]

Capture a southern continent first.

[emacknight]

Originally Posted by John Mace

is this a spin-off from the What Should Replace Capitalism thread, where some were arguing that workers get a share of the profit?

Personally I was hoping it would be a sticky that people could refer to if ever they thought that labour risked as much as the investor.

It has showed up in almost all of Le Jacquelope's, as well as the union busting threads, most recently here:

Originally Posted by Little Nemo

Isn't the cashier investing his time as much as the store owner or neurosurgeon? Why is their time worth something and the cashier's isn't?

There is a misconception that employees are entitled to share in the profits, because there is a misconception that employees share in the risk.

Both a coal miner and a firefighter face risk in the form of injury/death, and in both cases each understand that risk and are compensated for it. If the level of risk is too high, they are free to work elsewhere. (with that said, it is NOT okay for management to have poor safety standards and procedures).

[XT]

Originally Posted by Whack-a-Mole

Unless you are a CEO of a bank or investment firm in which case you can apparently bring your company to the brink of ruin, smash the global economy and collect record bonuses for doing it.

And none of those guys lost their jobs and their reputations? None of them lost large amounts of money in their investments?? They all got large bonuses for destroying their companies and 'smashing the global economy'?

The fact that some people managed to skate out of what happened does not prove that CEO's of large companies, including banks, don't have any risks associated with their positions.

And even if they did lose their job they have golden parachutes that keep them from sharing anything like what we would call risk.

Again, that doesn't mean that they were above risk. Most of those folks will not be able to find jobs again. Many of them took hits in their personal investments. A lot of them lost more than money (which after a certain point just becomes a marker for judging your relative worth compared to your peers)...their reputations were destroyed.

-XT

[SeldomSeen]

That's a pretty good analogy, but just a couple o' nitpicks. First, this situation only applies to a proprietorship - typically a one-person business or a mom-n-pop operation. Anything larger will usually incorporate, with a board of directors and stockholders (who may, in a small enterprise, be the same or some of the same people who run it). But the big difference with a corporation is that the general manager, who may also be the primary stockholder, will ordinarily be paid a salary. Even when a business is in the red, the manager/majority owner will still be paid that salary. It's written off as a business expense as long as there's some money in the till to cover it. When the corporation runs out of money and credit, it enters bankruptcy.

Also, while this is not really relevant, A vineyard usually takes more than three years to turn a profit. Three years is the time it takes to get a first crop and any kind of return from wine grapes. Table grapes do it in two. The actual time to recover the cost of planting may take up to 8-10 years.
SS

[emacknight]

Originally Posted by Nadir

I'd title the thread "Understanding Small Business Risk."

Why we need a thread helping people understand risk.

Yes, the example provided is based on the simplest form of a business involving 4 people.

Very little changes when you have a massive restaurant chain. There might now be multiple owners and outside investors sharing the risk. In between there will be more skilled workers, more commissioned sales people, and more general labourers at the bottom. Risk is still there.

Originally Posted by Whack-a-Mole

Unless you are a CEO of a bank or investment firm in which case you can apparently bring your company to the brink of ruin, smash the global economy and collect record bonuses for doing it.

And even if they did lose their job they have golden parachutes that keep them from sharing anything like what we would call risk.

Again, misunderstanding of the concept.

Your first mistake was assuming that the CEO = owner. Share holders were the owner--they risked, and they lost. Look at the 5 year chart for AIG to understand this.

Please add this to the sticky.

The CEO is part of the "skilled trade" akin to the chef. Also note that the CEO generated HUGE profit during the "good" years. They also had opportunity cost of working at a successful financial company that didn't go broke.

There were CEOs of companies that did very well through the recession. I can guarantee you that what ever you think of those "bonuses and golden parachutes" you mentioned, the CEOs of successful companies will get far richer having made better choices.

The crappy CEOs you mentioned are now worth less than the successful ones, and will garner a lower wage as a result.

[Whack-a-Mole]

Originally Posted by xtisme

And none of those guys lost their jobs and their reputations? None of them lost large amounts of money in their investments?? They all got large bonuses for destroying their companies and 'smashing the global economy'?

The fact that some people managed to skate out of what happened does not prove that CEO's of large companies, including banks, don't have any risks associated with their positions.



Again, that doesn't mean that they were above risk. Most of those folks will not be able to find jobs again. Many of them took hits in their personal investments. A lot of them lost more than money (which after a certain point just becomes a marker for judging your relative worth compared to your peers)...their reputations were destroyed.

Not sure what planet you have been living on.

US bankers set for record pay and bonuses for second year

Pay and bonuses at US banks and hedge funds are set to rise 4% this year – outpacing the growth in revenues – study finds

US bankers are set for record compensation for a second consecutive year, shattering both the illusion of pay-reform and the expectation that bank bonuses would be tempered while the US economy remains weak.

SOURCE: http://www.guardian.co.uk/business/2...rd-pay-bonuses

Were a lot of them fired? Maybe some were but I sure never heard about a mass clean out of the top. Most kept their jobs.

As for losing money on their investments remember a lot of their compensation is in the form of stock options. Also:

Since Obama was inaugurated, the Dow Jones has increased more than 50% -- from 8,000 to more than 12,000...

SOURCE: http://www.salon.com/news/opinion/gl...011/03/27/koch

I'd say they are doing fine.

[Whack-a-Mole]

Originally Posted by emacknight

Again, misunderstanding of the concept.

Your first mistake was assuming that the CEO = owner. Share holders were the owner--they risked, and they lost. Look at the 5 year chart for AIG to understand this.

CEO's are often substantially invested in the company they run. Stock options are a huge part of their overall compensation. They may not be the majority owner (although they might be) but they do have some ownership in the company.

As for AIG:

NEW YORK — American International Group Inc. is set to pay out about $100 million in a fresh round of bonuses to employees of its financial products division, the unit whose risky bets helped sink the company leading to a $180 billion government bailout, according to reports published Tuesday.

<snip>

New York-based AIG faced intense public and Congressional criticism last March when it paid out hundreds of millions of dollars in retention bonuses to employees months after receiving the government bailout.

SOURCE: http://www.huffingtonpost.com/2010/0..._n_447025.html

So, drive the company into a ditch, reap rewards.

[emacknight]

Originally Posted by Whack-a-Mole

As for losing money on their investments remember a lot of their compensation is in the form of stock options.

Exactly, and those options become worthless when the stock value falls. Would you like to me start a thread "understanding stock options"?

In the most simplest sense, the "option" only has value above the price that it was awarded. If the CEO of AIG got a billion options valued at $1000 per share, they are worthless at anything below $1000 per share, completely worthless.

Originally Posted by Whack-a-Mole

I'd say they are doing fine.

I'd say you don't know what you're talking about.

I'd also say that "fine" is a relative term. Are they fine compared to you, or fine compared to their peers at companies that didn't get destroyed?

ETA If the CEO is invested in the company the CEO faces risks just like all the other investors.

As to "$100 million in a fresh round of bonuses" the point here is, "what would they be if the company was successful? In other words, it's all relative.

[Whack-a-Mole]

Originally Posted by emacknight

Exactly, and those options become worthless when the stock value falls. Would you like to me start a thread "understanding stock options"?

In the most simplest sense, the "option" only has value above the price that it was awarded. If the CEO of AIG got a billion options valued at $1000 per share, they are worthless at anything below $1000 per share, completely worthless.

I'd say you don't know what you're talking about.

I'd also say that "fine" is a relative term. Are they fine compared to you, or fine compared to their peers at companies that didn't get destroyed?

I don't understand?

Please find me a story of some Wall Street bank CEO losing his shirt.

I see stories of record bonuses being paid (I just cited it in post #13). Even if some few schmucks lost everything most made out quite well. Show me a small business owner who could screw things up as massively as they did and not be in the poor house after losing everything.

And by "doing fine" I do not give a rat's ass if the CEO down the street made $100 million and the poor banker next door made a mere $50 million. He may be "poor" compared to his peers but so what? He is hugely wealthy by any definition of the term.

[Bosstone]

Originally Posted by Whack-a-Mole

I don't understand?

Please find me a story of some Wall Street bank CEO losing his shirt.

I see stories of record bonuses being paid.

As much as I want to agree with you, I think you're missing the thrust of the OP. The CEO is not the owner. The CEO has not invested personal capital into the company, only managed the capital that exists. The CEO is an employee and is being paid out like the dishwasher in the OP; the owners of the company have promised the CEO that money and so it shall be paid regardless of the performance of the company. The owners, the shareholders, are in fact losing out and are not able to recoup capital precisely because they have to pay out these stupid bonuses.

At least, that's how I understand it in an abstract sense. Specific cases may be different.

[XT]

Originally Posted by Whack-a-Mole

So, drive the company into a ditch, reap rewards.

Wait...what?? The CEO of AIG who was in charge prior to the melt down lost his job and then, IIRC, refused his 'golden parachute'. The 'record bonuses' were for the folks who were trying to dismantle the company so that it could be sold off to pay back what was owed the government. You seem to be going back and forth between CEO's, executives, and high level senior management types. All of those are different, distinct positions with various levels of risk associated with them.

-XT

[Giles]

Originally Posted by emacknight

2. The chef/cook is a skilled tradesmen. She risks her time, in that her ability to develop her skills impacts her future earnings. A year spent in a failed restaurant may make her worth less than a competing chef at a successful restaurant. But note that she'll still be paid her hourly wage for showing up and cooking. ...

If customers don't show up, the cook will still be paid, ...

The cook does not necessarily get paid. If the restaurant goes very badly, and the owner goes bankrupt, the cook is an unsecured creditor, and may get part or none of the wages owing. It's not that unusual for employees (skilled or unskilled) not to get paid because the business fails, and the risk can be higher in some kinds of industry.

[XT]

Originally Posted by Giles

The cook does not necessarily get paid. If the restaurant goes very badly, and the owner goes bankrupt, the cook is an unsecured creditor, and may get part or none of the wages owing. It's not that unusual for employees (skilled or unskilled) not to get paid because the business fails, and the risk can be higher in some kinds of industry.

That's going to vary wildly depending on the restaurant. In some restaurants the head cook might be a stakeholder and base their salary on profits from the company (more profits, more salary...greater risk vs greater reward). But most of the cooks I know get a salary just like everyone else...and if they aren't getting paid then like the dishwasher and the waiters they are free to take their labor elsewhere. Right? The only way I can see a head cook staying on if they weren't getting paid is if they had a direct stake in the company.

-XT

[emacknight]

Originally Posted by Whack-a-Mole

I don't understand?

That is correct, you don't understand award options as they pertain to employees of publicly traded companies. When the company fails, the options are worthless.

Originally Posted by Whack-a-Mole

Please find me a story of some Wall Street bank CEO losing his shirt.

No, I'm not doing your homework for you.

Originally Posted by Whack-a-Mole

I see stories...

Confirmation bias. You see the stories you want, and ignore the stories that fail to fit your narrative. You also assume that "lack of stories" implies lack of occurrence.

Yesterday, I noticed a story about a house fire, but I didn't see any stories about houses that didn't burn. What can we conclude?

Originally Posted by Whack-a-Mole

Show me a small business owner who could screw things up as massively as they did and not be in the poor house after losing everything.

That's the point of this thread: understanding risk. The owner risks losing everything and ending up in the poor house. The dishwasher does not.

Originally Posted by Whack-a-Mole

And by "doing fine" I do not give a rat's ass if the CEO down the street made $100 million and the poor banker next door made a mere $50 million. He may be "poor" compared to his peers but so what? He is hugely wealthy by any definition of the term.

I don't care what you consider hugely wealthy, it's not relevant to the discussion. Do you see the different between $100million and $50million? Are you aware that they are not the same thing?

If I offered you the choice between $100million and $50million which would you choose?

The difference between those two numbers represents risk. Both took risk, for one it paid off.

[Whack-a-Mole]

Originally Posted by Bosstone

As much as I want to agree with you, I think you're missing the thrust of the OP. The CEO is not the owner. The CEO has not invested personal capital into the company, only managed the capital that exists. The CEO is an employee and is being paid out like the dishwasher in the OP; the owners of the company have promised the CEO that money and so it shall be paid regardless of the performance of the company. The owners, the shareholders, are in fact losing out and are not able to recoup capital precisely because they have to pay out these stupid bonuses.

At least, that's how I understand it in an abstract sense. Specific cases may be different.

As I noted the CEOs are almost always invested in the companies they run. Frequently a sizable chunk of their pay comes in stock options.

It is not uncommon for the CEO to also be the majority shareholder. For example Rupert Murdoch is the majority shareholder of News Corp and he is the Chairman and CEO of News Corp.

Likening the CEO as akin to any paid employee simply is not the case (or rarely is).

[Whack-a-Mole]

Originally Posted by emacknight

That is correct, you don't understand award options as they pertain to employees of publicly traded companies. When the company fails, the options are worthless.

Yeah...except tax payers bailed these guys out. They then collected sizable bonuses and compensation.

Originally Posted by emacknight

No, I'm not doing your homework for you.

Confirmation bias. You see the stories you want, and ignore the stories that fail to fit your narrative. You also assume that "lack of stories" implies lack of occurrence.

Do the work for me?

That is rich.

Of the two of us I am the only one who has provide cites.

If you want to debunk those assertions and support yours then you need to find your own cites.

Or admit you got nothing...

[emacknight]

Originally Posted by Giles

The cook does not necessarily get paid. If the restaurant goes very badly, and the owner goes bankrupt, the cook is an unsecured creditor, and may get part or none of the wages owing. It's not that unusual for employees (skilled or unskilled) not to get paid because the business fails, and the risk can be higher in some kinds of industry.

Yes, this is correct in the sense that you made them unsecured creditors, but they also have at least some guarantee.

The distinction here is that the owner/investor only gets paid from profits. The cook/waitress/dishwasher get paid as part of operating costs.

The person that rents the space has risk that he won't get paid, just like the guy that supplies produce.

But all of those players get paid before the owner sees a dime of it.

[Voyager]

The example is a bit simplistic, in that it doesn't account for upside potential.

The owner may be putting her own money in, but she might also have collected money from a pool of investors, in the way VCs do. Assuming she does this well, she can reduce everyone's risk by reducing their contribution to levels they can afford to lose. Losing 5% of your money is a lot different from being wiped out. The investors, like those in VC funds, may diversify their money to contain their risk.
The chef may be an employee. If, however, he is a highly skilled chef, he may get profit participation without putting his money at risk - similar to the first employees at a startup. He risks his reputation and earnings at an established restaurant (though hardly any non-chain restaurants are that safe) but to a large extent his rewards depend on his skills.
In a similar vein, it is odd to talk about the opportunity costs of a CEO not being in a successful company, since we'd expect it quite possible he'd have run the successful company into the ground also.
The waitress share some of the risk but little of the upside. If the restaurant is a bomb, her tips will suffer and she'll have to live on her wages. There is also the risk of being thrown out of work. If the restaurant thrives she'll have a job, but there is a limit to her tips, partially based on her skills, since better servers can go to fancier restaurants and make more money off of higher bills.
The dishwasher is a commodity, and doesn't share much of anything.
The big problem with the OP is that it assumes that only the investor deserves upside benefit. If the restaurant is a success, the reason isn't that her money is any greener than anyone elses. The more an employee can contribute to the success, the more that employee deserves of the upside benefit. Is it a right? No. But not doing it will leave you with employees convinced they can't contribute, and you're going to be in trouble.
BTW, to go back to the banks, I assume you are then saying that the traders who don't have money invested in the bank, and no more reputation than the waitress, don't deserve bonuses?

[Frylock]

I'm someone who sometimes finds himself thinking workers should get a share of the profits. My thoughts are formed as a result of roughly marx-y (yeah I said it) worries about exploitation etc. So I take it I'm one target of the OP.

The OP only works on a presumption that the system works on the basis of wages. But what a lot of people think (I may sometimes think this) is that the very idea of "wage labor" is broken from the start.

You may have accurately described how a wage labor system can be made to work--but wage labor itself may be a bad idea. Perhaps it should be that everyone participating is risking something thereby, and not just these few in whom capital is concentrated. Maybe it shouldn't be that the dishwasher washes dishes by virtue of having been hired out to work at a certain wage, but rather, washes dishes by virtue of having invested his own capital in the system and having found that his own best way of helping that investment get a return is by washing the dishes.

I don't know how to make such a system work, scale up, etc, nor do I know whether it can do so, but I'm just pointing out that many of the presuppositions in the OP are simply not shared by some people who say things like "workers should get a share of the profits."

Sure, in a capitalist system it might not be workable to divide profits between everyone (it might--depends on what the market determines) but if the system isn't a capitalist one, such presuppositions about workability go out the window.

An unrelated suggestion: It may be that "risk" isn't the only thing we should measure appropriate rewards by. (Now I'm allowing myself to moralize the topic as the OP implicitly does--but I want to register that I'm not comfortable with doing so.) Perhaps differentials in degrees of freedom also should be taken into account. The people likely to become dishwashers, by and large, simply don't have the power to easily do any other kind of job. So one guy risks more, and so maybe should be rewarded more. But another guy has been for all intents and purposes forced to have the kind of job he has (if not that specific job)--and so maybe "reward" isn't the right word to use here, but perhaps the guy deserves something different--something more--than merely the wage he "agreed" to.

[Giles]

Originally Posted by emacknight

But all of those players get paid before the owner sees a dime of it.

That's right. Unless the owner is cheating by taking money out of the business and hiding it from the creditors, the owner has the greatest risk. (And if the owner is cheating then there's a risk of being caught and sent to prison.)

[emacknight]

Originally Posted by Whack-a-Mole

Of the two of us I am the only one who has provide cites.

If you want to debunk those assertions and support yours then you need to find your own cites.

Or admit you got nothing...

Ah yes, demand I got nothing, although way better if you use the nuthin'

Let's see what happens if instead of googling terms that confirm your bias, we look for things that disprove it, you know, like doing honest research instead of desperately attempting to support a misguided nothing.

CEO Firings On the Rise As Downturn Gains Steam (JANUARY 13, 2009)
"William Watkins, ousted Monday at Seagate Technology LLC, is the sixth CEO of a publicly held company to be replaced in just the last eight days. His exit follows the departures last week of CEOs at Tyson Foods Inc., Borders Group Inc., Orbitz Worldwide Inc., Chico's FAS Inc. and Bebe Stores Inc."

[Voyager]

Originally Posted by Whack-a-Mole

As I noted the CEOs are almost always invested in the companies they run. Frequently a sizable chunk of their pay comes in stock options.

It is not uncommon for the CEO to also be the majority shareholder. For example Rupert Murdoch is the majority shareholder of News Corp and he is the Chairman and CEO of News Corp.

Likening the CEO as akin to any paid employee simply is not the case (or rarely is).

Murdoch is also the owner of News Corp. Company founders may have lots of stock. CEOs of large, publicly traded companies typically have very little. The CEO of the old AT&T had practically none. I doubt Carley Fiorina had significant amounts of HP stock. She was certainly equivalent to an employee, though one who got a nice payment for screwing the company up.

[Voyager]

Originally Posted by emacknight

Exactly, and those options become worthless when the stock value falls. Would you like to me start a thread "understanding stock options"?

In the most simplest sense, the "option" only has value above the price that it was awarded. If the CEO of AIG got a billion options valued at $1000 per share, they are worthless at anything below $1000 per share, completely worthless.

Stock options don't cost the employee anything, and losing theoretical value is not the same as losing money in a real investment. Trust me - I've lost more imaginary money in investments than I like to think about. Options are given (or were) because there are tax implications on too much salary.

[Whack-a-Mole]

Originally Posted by Voyager

I doubt Carley Fiorina had significant amounts of HP stock. She was certainly equivalent to an employee, though one who got a nice payment for screwing the company up.

She apparently had a lot of stock options.

Fiorina received $21 million in severance pay when she was fired as CEO of Hewlett Packard in 2005. She received an additional $21 million when Hewlett Packard's board bought out her company stock options and pension benefits. Her compensation package sparked a lawsuit from shareholders.

SOURCE: http://www.huffingtonpost.com/2008/0..._n_128277.html

[Nadir]

Originally Posted by xtisme

Why?

Different endeavors engender different types of risk, and different levels of the same type risk, based on scope.

It's all about risk management.

[Whack-a-Mole]

Originally Posted by emacknight

CEO Firings On the Rise As Downturn Gains Steam (JANUARY 13, 2009)
"William Watkins, ousted Monday at Seagate Technology LLC, is the sixth CEO of a publicly held company to be replaced in just the last eight days. His exit follows the departures last week of CEOs at Tyson Foods Inc., Borders Group Inc., Orbitz Worldwide Inc., Chico's FAS Inc. and Bebe Stores Inc."

I never said CEOs never get fired.

Watkins' risk for doing a bad job? A $5million severance.

The company also said it has reached a separation agreement with Watkins that will pay him $5,000,008 in cash, consisting of 24 months of annual salary and 2x his target bonus for the company’s prior fiscal year.

The cash is to be paid in two installments, half before February 26, and the rest within 10 business days of December 2, 2009. He’s also to be paid $29,944 to cover health insurance. Watkins also agreed to serve as a consultant to the company until December 2 on an as-needed basis at a $500 hourly rate.

SOURCE: http://blogs.barrons.com/techtraderd...everance-deal/

I just noted Carly Fiorina's severance.

I wish I got paid so well for screwing up. I would be thrilled with that kind of "risk" in my job.

[Algher]

Smart CEOs have a Change in Control Agreement, trust for pension, and a pre-agreed upon severance agreement - all negotiated in advance. You can read the details in a company's def14A / Proxy statement on file with the SEC and available online.

The Senior Management of Lehman didn't parachute out.
The Senior Management of Arthur Andersen didn't parachute out.
The Senior Management of Enron didn't parachute out.

There are plenty of examples of CEOs NOT making it out with a lot of money, others with getting their parachute, others with being paid off rather than having a court fight.

None of which is relevant to risk. In a public corporation, it is the investors with the risk, and the investors with the reward.

[emacknight]

Originally Posted by Voyager

The example is a bit simplistic, in that it doesn't account for upside potential.

The owner may be putting her own money in, but she might also have collected money from a pool of investors, in the way VCs do. Assuming she does this well, she can reduce everyone's risk by reducing their contribution to levels they can afford to lose. Losing 5% of your money is a lot different from being wiped out. The investors, like those in VC funds, may diversify their money to contain their risk.

You started buy mentioning upside potential, then went on to describe out to spread risk, but forgot to mention that you are also spreading the upside potential.

In the OP the owner is 100%. That should just as easily be 100 people putting in 1%.

So owner at 100% will get (and deserves) 100% of the rewards, because she is taking on 100% of the risk.

If instead 100 people by a lottery ticket, they each risk 1cent, but they also share the reward. They don't each win $1million, they win 1/100th of the profits.

Originally Posted by Voyager

The chef may be an employee. If, however, he is a highly skilled chef, he may get profit participation without putting his money at risk - similar to the first employees at a startup. He risks his reputation and earnings at an established restaurant (though hardly any non-chain restaurants are that safe) but to a large extent his rewards depend on his skills.

Yes, the skilled tradesman risks his career and reputation, the way a CEO does.

It is entirely possible to blur all this and create confusion by trying to go back and forth with CEO as owner, or chef as owner. There are plenty of examples of that, and plenty where CEO/chef is just an employee.

But it doesn't change the nature of risk.

At any point an employee can decide to incur risk. The labourer at the bottom could just as easily say that he wants a stake in the profits. But to do that he'll have to risk his capital. He could put up cash, he could buy equipment, or he could forgo salary. All incur risk, and from my experience 99 times out of 100 employees don't want to be part of the risk. They want to show up, and get paid.

Originally Posted by Voyager

In a similar vein, it is odd to talk about the opportunity costs of a CEO not being in a successful company, since we'd expect it quite possible he'd have run the successful company into the ground also.

Sorry, that wasn't the point of the comparison.

The comment made was that shitty CEOs still got bonus, to which I countered the successful ones got better bonuses. The shitty CEOs took risks and lost.

Originally Posted by Voyager

The waitress share some of the risk but little of the upside. If the restaurant is a bomb, her tips will suffer and she'll have to live on her wages. There is also the risk of being thrown out of work. If the restaurant thrives she'll have a job, but there is a limit to her tips, partially based on her skills, since better servers can go to fancier restaurants and make more money off of higher bills.

You've confused a few terms here. The waitress in essence is a contract work who chooses to align herself with a particular product. First and foremost she needs sales volume to generate tips (commissions). But as the product (restaurant) becomes more successful she'll generate higher commissions.

With that said, there is a high degree of skill to the sales position that I had no intention of dismissing. A great waitress (like a great dishwasher) is a highly valuable asset. Which is why she incurs opportunity cost when she chooses one restaurant over another.

Originally Posted by Voyager

The dishwasher is a commodity, and doesn't share much of anything.
The big problem with the OP is that it assumes that only the investor deserves upside benefit. If the restaurant is a success, the reason isn't that her money is any greener than anyone elses.

Well, yes, that is the point of the OP, the investor is the one that stands to lose capital. No one else.

Originally Posted by Voyager

The more an employee can contribute to the success, the more that employee deserves of the upside benefit.

No, the more an employee contributes the more they should be rewarded for their skill, that is where compensation packages kick in. That is where you will stock options awarded to CEOs, because stock options are only valuable if the stock is up, and worthless if they are down.

That is an investment decision: what chef do you choose, and how do recruit her, and how do you retain her?

In that case, a chef/CEO might invest their time (which has value) and risk losing if the restaurant fails.

[emacknight]

Originally Posted by Whack-a-Mole

I never said CEOs never get fired.

Watkins' risk for doing a bad job? A $5million severance.

What did he stand to gain?

Why are you so resistant to understanding risk? What do you stand to lose? Would gaining knowledge not be slightly more valuable than trying to save face?

The $5milliion severance was not his risk. He got fired for doing a bad job. Had he done a good job he would continue to be employed making way more than $5million.

I don't know (or care) what you do, but let's say you make $20k a year. If you fuck up you stand to lose that job. If you do fuck up and they give you a $50 compensation package, what did risk? Was it $50 or $20k?

As we keep telling you, a CEO position is a skilled job, meaning that Watkin's now has to look for another job while carrying the shame of fucking up Seagate. Do you think he's worth more now or less? Seagate stock went from almost $30 to almost $3. Would Emc Corp., Brocade Communications, Sandisk, or Western Digital want to hire him?

You also glossed over the fact that his options AND pension were bought out, you forgot the part where his pension was bought out, in order to make it look like his options were worth more.

Originally Posted by Whack-a-Mole

I wish I got paid so well for screwing up. I would be thrilled with that kind of "risk" in my job.

Again, I don't care what you do, but what risk do you carry? If you want to be paid more get a better job. She would have gotten paid more had she done a better job.

[carm]

In the restaurant of the OP, sure, the owner has the greatest risk.

Now imagine another restaurant, except this time the owner has several other business investments. Lets suppose he owns ten restaurants. Now, all the owner is risking is 10% of his capital. If the restaurant goes under, who cares? He has another nine. The staff, on the other hand, now find themselves unemployed. They have arguably lost more (their entire livelihood) than the owner, who is still a long way from the poor house.

You have picked the perfect scenario to come up with the conclusion you wanted, ie that capital owners risk everything and labour risk nothing.

[Strassia]

Then there is the leveraged buyout in which the new owner assumes little to no risk by financing the purchase with loans against the company. Then you run the company in the way that maximizes short term profit, pay yourself the best dividends you can, and when you don't think you can squeeze any more profit out, sell whats left for as much as you can or declare bankruptcy. No risk, maximum profit.

Listen to the story to find out how LBOs mean your new mattress will probably not last as long as your old one.

[emacknight]

Originally Posted by xtisme

It shouldn't really be a debate, but I'm guessing that it will turn into one.

-XT

And here we are, knee deep in it trying to explain stock options and contractual obligations.

And for the record: in the OP the cook, waitress, and dishwasher can and do screw up, and those screw ups can and will destroy the restaurant.

With that said, it is no uncommon to have someone fired and be told they'd be paid for the rest of the week. I think we can all agree getting a week's pay doesn't make up for a yearly salary.

And there is no reason why any of the players can't negotiate a severance as part of employment.

[emacknight]

Originally Posted by carm

Now, all the owner is risking is 10% of his capital. If the restaurant goes under, who cares?

He cares! It doesn't matter how much of his total capital he invests, he still stands to lose 100% of that investment. Just because YOU think it's chump change he probably wants that money. In fact, research shows people feel a loss much more strongly that a win.

I feel each any everyone one of my failed stock trades, regardless of how small the loss.

What if I said, "meh, he has 9 other kids, he can stand to lose one."

Even in your scenario, he is taking the risk, no one else. So why shouldn't he stand to make gains off the profit?

[TriPolar]

The chef risks little if he/she is not an owner. Even the damage to reputation is minimized since he can demonstrate skills, and blame the restaurant's failure on the owner. The waitress risks nothing since she will leave at any time for a better job if it's available. The only possible risk for the dishwasher and the waitress are not getting their final paycheck (which for the waitress may be a minor part of her take home). The rewards for the chef, waitress, and dishwasher are paychecks at fixed rates (and some amount of tips), but the return is unrelated to investment. The owner risks everything, the employees, nothing really.

A better understanding of investment and risk can be seen through the owners investment in incentives for the employees and customers. All the restaurant owners I know will provide bonuses to employees as an incentive. They range from free food to extra pay. It's common to pay employees in restaurants cash off the books so they can save on taxes. This essentially comes out of the owner's pocket (and the governments if he's taking out cash and not reporting it). When he prices meals, advertises, runs specials, etc., he is investing in marketing to gain an increase in business. The benefits of those investments have to result in enough increased business to justify the costs. That can be very difficult to determine because the benefits can be very indirect. For instance, it's beneficial to lose money on a meal sold at a low price if it gains the restaurant a regular customer.

For full disclosure, I once owned a restaurant.

[carm]

Originally Posted by emacknight

He cares! It doesn't matter how much of his total capital he invests, he still stands to lose 100% of that investment. Just because YOU think it's chump change he probably wants that money. In fact, research shows people feel a loss much more strongly that a win.

I feel each any everyone one of my failed stock trades, regardless of how small the loss.

What if I said, "meh, he has 9 other kids, he can stand to lose one."

Even in your scenario, he is taking the risk, no one else. So why shouldn't he stand to make gains off the profit?

Obviously he cares, I wasn't actually looking for an answer to that question. But you suggest that whenever a business fails its owner loses everything, which is miles from the truth. Most people with money to invest spread out their investments, precisely so that when one fails they don't lose everything.


You don't think employees have anything to lose if the business closes? Ever been unemployed or poor? Ever struggled to pay bills? The point is, it hurts a lot more to lose your job when trying to support a family than to lose 10% of your riches when wealthy. You don't seem to consider losing a job actually losing something, because you have no money invested.


Do the employees lose anything when the business fails? Or do they all walk to the restaurant across the road and get instantly rehired, as so often happens in economic fantasy-land? What if the business fails during a time of high unemployment, and the staff can't find new jobs?
Who loses more then?

[Rand Rover]

Great OP. It will of course have zero impact on the target audience. They want what they want, and if you don't want it too then you are a bad person who must be resisted.

[Voyager]

Originally Posted by Whack-a-Mole

She apparently had a lot of stock options.

Stock options convey neither ownership nor votes. They are of potential value only when issued. I got to take losses for the stock I owned, but not for any options I owned when the expired underwater.

[Chronos]

What's the point of the OP supposed to be? Is it that the owners should get all (or the significant majority) of the profits, since they face all (or the significant majority) of the risk? But why would risk be the only thing that deserves profit? The chef might not have much risk himself, but the quality of the food he makes is going to change how much risk there is to the owner. If you've got a really good chef who turns your restaurant from being an iffy proposition to a sure thing, doesn't he deserve a reward for that?

[XT]

The chef isn't a slave though...if s/he doesn't think they are being compensated adequately then they are free to take their labor to another restaurant and negotiate a better deal.

The owner is the one risking his or her capital on the venture though. Without that capital then the chef, the waiter and the dishwasher don't have a job at that particular restaurant. They would have to compete at a different restaurant...one that has an owner that was willing to pony up the capital to open that establishment and thus open the opportunity for employment by our trio.

-XT

[Chronos]

Well, yes, but without the chef, the waiter, and the dishwasher, the owner wouldn't have those particular employees, either. But the owner is free to approach other employees and negotiate a better offer with them. The owner isn't a slave, either.

[Voyager]

Originally Posted by emacknight

You started buy mentioning upside potential, then went on to describe out to spread risk, but forgot to mention that you are also spreading the upside potential.

In the OP the owner is 100%. That should just as easily be 100 people putting in 1%.

So owner at 100% will get (and deserves) 100% of the rewards, because she is taking on 100% of the risk.

If instead 100 people by a lottery ticket, they each risk 1cent, but they also share the reward. They don't each win $1million, they win 1/100th of the profits.

Yes, obviously the upside potential for investors is in proportion to their investment. But that's not the upside I mean.

Yes, the skilled tradesman risks his career and reputation, the way a CEO does.

It is entirely possible to blur all this and create confusion by trying to go back and forth with CEO as owner, or chef as owner. There are plenty of examples of that, and plenty where CEO/chef is just an employee.

But it doesn't change the nature of risk.

No, I'm not claiming that the chef has a role as either owner or CEO. A noted chef is not going to work for salary only - he'll want part of the success that he helped to create. There are examples of this throughout many industries, from CTOs of startups getting stock to actors getting a share of the profits of a movie (and let's not get into a Hollywood accounting discussion.)

At any point an employee can decide to incur risk. The labourer at the bottom could just as easily say that he wants a stake in the profits. But to do that he'll have to risk his capital. He could put up cash, he could buy equipment, or he could forgo salary. All incur risk, and from my experience 99 times out of 100 employees don't want to be part of the risk. They want to show up, and get paid.

Not at all correct. I shared in the profits of my company through options without putting a penny at risk. Before the tax decision. many, many workers did, including Admins.
The bonus system, which is on top of this, can be said to put money at risk because perhaps we'd get some of the bonus money as salary - but it mostly involved extra money coming out of profits, with nothing really at risk. Certainly my offer when I started was competitive without considering bonuses at all.

Sorry, that wasn't the point of the comparison.

The comment made was that shitty CEOs still got bonus, to which I countered the successful ones got better bonuses. The shitty CEOs took risks and lost.

I'm not sure then what you mean by opportunity costs. That would seem to imply they could have done better going elsewhere, when in fact their supposedly shitty bonus was a result of their own performance. I'd also want to see some evidence that poorly performing CEOs do get bad bonuses. Compensation committees for very large companies are often in the pocket of the CEO, and if the CEO is doing that badly they tend to get fired, not take rotten bonuses. Good ones voluntarily renounce direct compensation in the place of options - which is often a good deal because at the time the stock prices is depressed and so they can make a bundle on the resurgence of the industry as a whole. This kind of compensation is usually based on absolute stock value, not value in relation to the competition.

You've confused a few terms here. The waitress in essence is a contract work who chooses to align herself with a particular product. First and foremost she needs sales volume to generate tips (commissions). But as the product (restaurant) becomes more successful she'll generate higher commissions.

Say she can handle 20 tables, and is the first server hired. The restaurant bops along at 20 customers, so she gets all the tables and tips. Now it takes off, and does 80 tables worth of business. 3 more servers have to be hired, and she still gets tips from the 20 tables she can handle. Assuming there is no increase in prices, the owners get the extra profit and she gets nothing.
If she is only doing 10 table worth of business then she does do better - until she hits the ceiling of the tables she can handle.

With that said, there is a high degree of skill to the sales position that I had no intention of dismissing. A great waitress (like a great dishwasher) is a highly valuable asset. Which is why she incurs opportunity cost when she chooses one restaurant over another.

True, if she can increase the amount of the average check she'll do somewhat better - but nowhere near as well as the owners.

Well, yes, that is the point of the OP, the investor is the one that stands to lose capital. No one else.

But in many cases the relative pain of a small investor losing capital is less than that of the dishwasher or waitress losing a job. It is marginal utility again.

No, the more an employee contributes the more they should be rewarded for their skill, that is where compensation packages kick in. That is where you will stock options awarded to CEOs, because stock options are only valuable if the stock is up, and worthless if they are down.

Initial compensation is based on the market and on potential. Only a foolish owner would award initial compensation based on the rosiest forecast of revenue. However if that does happen, and he doesn't share the profits with the chef, he risks losing the competitive advantage of the restaurant. it is clearly to the owner's advantage to make this a profit sharing plan, not a compensation increase only plan, since then he is protected from the downside to a certain extent - like the chef losing interest.
And CEOs are hardly the only people getting stock options.

[Voyager]

Originally Posted by xtisme

The chef isn't a slave though...if s/he doesn't think they are being compensated adequately then they are free to take their labor to another restaurant and negotiate a better deal.

The owner is the one risking his or her capital on the venture though. Without that capital then the chef, the waiter and the dishwasher don't have a job at that particular restaurant. They would have to compete at a different restaurant...one that has an owner that was willing to pony up the capital to open that establishment and thus open the opportunity for employment by our trio.

-XT

No one is saying that the owner should be forced to share profits. However, an owner who takes all the profits because he has all the risk is not likely to be very successful for long, especially if there are crucial employees. Risk is only part of the equation.

[XT]

Originally Posted by Chronos

Well, yes, but without the chef, the waiter, and the dishwasher, the owner wouldn't have those particular employees, either. But the owner is free to approach other employees and negotiate a better offer with them. The owner isn't a slave, either.

Exactly. Both parties are free to push for the terms they feel are advantageous to themselves. If the owner REALLY wants that chef or that waiter (or even that dishwasher), they they will be prepared to pay a premium for a particular individual in the hope/expectation that it will increase the potential profitability of the venture. The chef, waiter or dishwasher may feel their labor is worth more (or less) than a particular owner is willing to pay, so both sides have to make a decision as to whether it's in their best interests to come to a mutual accommodation.

The owner, however, having put up the capital to make the whole thing possible will obviously reap the biggest potential rewards, while the others (assuming they aren't stakeholders) will reap rewards consummate to their ability to make the venture successful.

-XT